Hello, and welcome to McDonald's October 21, 2011 Investor Conference Call. As a request from McDonald's Corporation, this conference is being recorded. [Operator Instructions] I'd now like to turn the conference over to Ms. Kathy Martin, Vice President of Investor Relations for McDonald's Corporation. Ms. Martin, you may begin.

Kathy Martin

Good morning, everyone, and thank you for joining us. With me on the call today are our Chief Executive Officer, James Skinner; and our Chief Financial Officer, Pete Benson. Today's conference call is being webcast live and recorded for replay via phone, webcast and podcast.

Before I turn it over to Jim, I want to remind everyone that as always, the forward-looking statements in our earnings release and 8-K filing also apply to our comments, and both documents are available at our website, www.investor.mcdonalds.com, as our reconciliations of any non-GAAP financial measures mentioned on today's call with our corresponding GAAP measures. Now I'd like to turn it over to Jim.

James A. Skinner

Thank you, Kathy, and good morning, everyone. I'm pleased to share the latest business results for McDonald's, which highlight our continued strength. For the third quarter, global comparable sales were up 5%, and constant currency's operating income increased 8%, and EPS increased 6% to $1.45.

Our global success continues with every area in the world contributing. In the United States, comparable sales for the quarter were up 4.4%, and operating income grew 6%. In Europe, comparable sales for the quarter increased 4.9%, and operating income grew 6% in constant currencies. And in Asia/Pacific, Middle East and Africa, comp sales for the quarter increased 3.4%, and operating income grew 15% in constant currencies. And our momentum, I'm happy to say, is continuing into October with global comparable sales expected to be up 4% to 5%.

McDonald's continues to drive results around the world by offering what customers are looking for today more than ever: great value, outstanding convenience, a modern restaurant experience and relevant, great-tasting menu offerings.

Our entire system of franchisees, suppliers and employers are aligned around our Plan to Win. And we continue to focus on executing at the highest level against our 3 global priorities: optimizing the menu with the right food and beverage offerings; modernizing the customer and employee experience by upgrading every aspect of our restaurants from service to designs; and broadening accessibility through continued convenience and value initiatives. Now as I've said before, it's not just one initiative but a combination of all of them that continue to drive our growth.

In the area of menu, we're seeing focused on the right balance of core products and new offerings are helping us stay relevant with consumers. We've continue to build on our equity in chicken. In the United States, this quarter, McNugget units were up nearly 10% over last year as we featured 4 new dipping sauces. In addition, our premium chicken sandwich line with the new flavor profile and bakery-style whole grain bun continued to perform strongly.

In Australia, we launched 2 new chicken offerings, a chicken and cheese snack and one with the bone-in McWings. And both have been strong sellers. And in Japan, a renewed focus on Chicken Tatsuta, a chicken sandwich helped grow sales.

Beverages also remain on opportunity around the world. In the United States, we energized our McCafé line with 2 additions: Frozen Strawberry Lemonade and Mango Pineapple Real Fruit Smoothies. These new offerings added to our specialty Beverage lineup, helped to increase total McCafé beverage sales by 16% over last summer's strong numbers.

McCafé is expanding globally as well. We're building the business across Europe, where we have more than 1,400 McCafés with Germany, leading the way at over 750. In APMEA, Australia has 650 McCafés, and we're planning to have approximately 250 in China by year's end. And while international McCafés are focused on hot beverages right now, we have a number of markets planning to test or add real fruit smoothies and frappes over the next few years, starting with Australia next month.

Our practice continues to be an important day part for McDonald's as well as an opportunity for the future. In China, breakfast is achieving double-digit comparable sales increases, and today has reached over 8% of sales. Europe has only begun to scratch the surface, with the U.K. continuing to experience strong sales results of 13% of sales. And in the U.S., where breakfast represents about 25% of sales, we've focused consumers in our lineup of wholesome offerings, from oatmeal and Egg McMuffin to our Yogurt Parfait and Fruit and Walnut salad. Total units on all of these products combined to increase more than 20% over last year and helped us to continue making gains during this very important part of the day.

In addition, premium products have continued to deliver results, with France being the most recent market-to-launch McWraps. These are large wraps with chicken or beef that have performed well across Europe.

Rounding out our menu news, Europe drove results with the use of customer-focused food events often featuring premium products. The U.K. built sales with a successful summer food event, highlighted by the return of the bacon chicken onion sandwich leveraging the success experienced in Europe, the U.S. is planning a number promotional food events in 2012 that will feature new food news.

Around the world, our markets are also making gains through strong experience in accessibility initiatives. Europe is furthest along in modernizing their restaurants with new and relevant designs to provide customers with a great experience. Each area of the world has benefited from Europe's experience and are making steady progress.

Meanwhile, all of our top markets continued their trend of improving customer satisfaction scores through a stronger focus on operations and service and technology, such as our new POS ordering system, which elevates speed and accuracy and is now in nearly all restaurants here in the United States.

On the accessibility front, we're staying focused on serving more customers more often in a variety of ways. Across all geographies, we continue to expand our extended hours in order to be able to be open and available when and where our customers want us to be. We're also growing capacity, especially at the drive-thru. Drive-thru optimizations help drive results across APMEA, with countries such as Australia, and Japan registering the Lipton sales with a focus on their service excellence at the drive-thru. In the U.S., we're also elevating their commitment to drive-thru by side-by-side drive-thrus, where real estate will allow on handheld order takers where space is limited.

We're also broadening our accessibility by continuing to offer the most relevant value. Our value programs in breakfast and lunch continue to be important to growth across APMEA, including Australia which has made gains from its new value campaign.

And all of our major markets in Europe continue to focus on the value provided by their popular mid-tier offerings, from Little Tasters in the U.K. to Snack Deluxe in Germany to P’tits Plaisirs in France. With new flavors and promotions, we're keeping these lines fresh and engaging for customers and elevating our position as a leader in great taste and quality at a great value.

We recognize today that the environment out there is still fragile. The economists say we're officially out of the recession. But it hardly feels that way. Unemployment is back up over 9% here in the U.S. and in similar rates around the world.

The stock market just ended its worst quarter in 2 years, and many major economies are barely growing, if at all. Consumers everywhere continue to be cautious and hesitant to spend, and the informal eating-out industry is growing at a very slow pace. So we remain in a market share battle, with every victory continuing to be hard won.

But we plan to keep winning. The examples I highlighted from across our system demonstrate how we strategically have strengthened our business in a comprehensive way. We remain committed to listening to our customers in meeting their needs at every turn, whether it's in today's environment or down the road as the economy improves.

Now moving forward, we're equally committed to maintaining a strong financial foundation and maximizing value for our shareholders. Our intent remains to return all of our free cash flow after reinvestment to investors through a combination of dividends and share repurchase. We recently announced a 15% increase on our quarterly cash dividend to $0.70 per share or the equivalent of $2.80 annually. And combined with share repurchases, we expect to total -- returned total cash to shareholders to 2011 to reach approximately $6 billion.

I'd like to say, overall, I'm very pleased with our latest quarterly performance. While the economic recovery continues to be fragile around the world, we stay focused on what we can control, staying committed to our winning plans and delivering an exceptional experience for our more than 64 million customers around the world every day.

I'm confident that by continuing to innovate, invest and execute, we will help to continue delighting our customers in growing our business around the world. Thank you, and now I'll turn it over to Pete Bensen, our CFO.

Peter J. Bensen

Thanks, Jim. Hello, everyone. McDonald's continued to deliver solid results despite another quarter marked by rising cost and macroeconomic uncertainty and volatility. We're successfully navigating through this environment because of our alignment and focus around the Plan to Win. This continues to yield significant increases in comparable sales, market share and operating income. Through the first nine months, revenues increased 8% in constant currency. And over that same period, our combined operating margin increased 40 basis points to 31.8%.

This 80% of our 33,000 restaurants are franchised. Our profitability is primarily driven by franchise margins. In the third quarter, franchise margins reached $1.9 billion, an increase of $133 million in constant currency, with each area of the world contributing to this growth. The franchise margin percentage for the quarter rose 40 basis points to 83.7%, driven by positive comparable sales.

Global company operating margin dollars increased to $26 million in constant currencies for the quarter to $972 million. The margin percentage decreased 100 basis points to 20% as strong comparable sales were more than offset by higher costs, primarily commodities.

In the U.S., the company operating margins declined 90 basis points to 21.1% for the third quarter due to an 8% rise in commodity costs, and to a lesser extent, higher occupancy and other costs, partly offset by positive comparable sales. The third quarter margin percentage benefited by about 40 basis points due to the recognition of a special payroll tax credit created by the HIRE Act.

These prices, which typically moderate after the summer, have remained high. As a result, we now expect commodity cost in the U.S. to be up a little more than previously expected, 4.5% to 5% for the full year, with fourth quarter increases easing compared to second and third quarter.

Partially offsetting the rising cost are the 2 price increases taken thus far in 2011, the 1% increase in March and the 1.4% increase at the end of May. We're seeing good flow-through to the bottom line from these increases. In addition, food-at-home inflation is rising faster than food away from home, which might allow for additional pricing actions in the near term. We will continue to evaluate additional price increases in light of this inflationary environment, always balancing our goal of driving traffic and market share gains with effectively managing the impact of rising costs. As we look into 2012, we expect commodity cost increases in the U.S. to be similar to this year's.

In Europe, third quarter company operating margins declined 110 basis points to 20.9%, primarily due to higher commodity and labor costs, also partly offset by positive comparable sales. In addition to prudently managing cost across the continent, our European management team has developed effective marketing plans that feature value throughout the menu to drive sales.

In third quarter, several premium products, offered in our predominantly reimaged interiors, were showcased within promotional food events. This included the Big Tasty in France, the Stars of America in Germany and the launch of the premium 1955 hamburger in the U.K.

Our price increases vary across the 40 European markets. Russia, which is experiencing higher inflation, is an outlier. Most other European markets are averaging year-over-year price increases around 2%. As we consider future price increases, we remain mindful of the extreme economic uncertainty, cautious consumer sentiment amidst the austerity measures and shrinking disposable income. we will continue to monitor this closely, aware of the ongoing inflationary pressures, while doing what is right to the long-term health of our business. Similar to the U.S., Europe slightly increases estimate for the full year commodity cost increase to 4.5% to 5% primarily due to higher beef costs. this implies the fourth quarter increase slightly above the annual guidance.

Turning to Asia/Pacific, Middle East and Africa, the company operating margins for the quarter decreased 50 basis points to 18.4%, also reflecting inflationary cost pressures partially offset by comparable sales increases. similar to the first half of the year, the acceleration of new restaurants, openings in China, negatively impacted this segment's margin percentage.

Menu continues to be a significant driver of comparable sales growth in APMEA. Innovative locally relevant product offerings of chicken, the dominant protein in this region, as well as breakfast, compelling value offerings and a sustained core menu focus are building loyalty among our customer base. Strong consistent financial performance from our unique business model generates meaningful amounts of cash flow. We reinvest the significant amount of this cash back into our business to drive future growth and returns.

Our restaurant development teams are making excellent progress against their plans for reimaging and building new restaurants, taking advantage of improved tools and capabilities. As a result, we are slightly increasing our 2011 capital expenditure guidance to $2.6 billion. Reimaging remains an immense opportunity for us because the majority of our exteriors and interiors do not reflect our current contemporary look.

We continue to make progress across the globe on our reimaging efforts. As of last week, we have completed over 360 reimages in the U.S., and given what we have under construction, we are on track to complete and likely exceed 600 by the end of the year. On average, it is taking about 8 weeks to complete the exterior and interior reimaging. And as we head into the winter months, construction times will likely increase.

During construction, the front counter is often closed for a period. But in nearly all cases, the drive-thru remains open to minimize any sales declines. Most of the other owner operators who have committed to reimaging their restaurants this year sought to avoid construction during the busy summer months. That explains why over 270 projects have broken ground since Labor Day.

Our owner operators remain committed to reimaging. Our pipeline of projects is growing because they also view this as an important evolution of our brand. I think it also speaks to their long-term commitment to making the necessary investments to keep McDonald's increasingly relevant to our customers.

In Europe, we have reimaged over 600 restaurants through September. France plan to have all of this interiors and half of its exteriors reimaged by the end of this year. And the U.K. expects nearly all of its restaurants will be reimaged by the end of 2012, having just recently completed its 1000th project.

In the APMEA, we're also making significant reimaging progress, having completed approximately 100 reimages in both Japan and China. Currently, about 20% of China's store base reflects the updated image. But with new restaurant openings and planned reimages, that number should approach what 40% by the end of next year.

We expect to open between 1,100 and 1,200 new restaurants this year on our base of 33,000, an increase of over 3%. New openings by areas of the world include over 150 in the U.S., more than 225 in Europe and about 650 in APMEA. China is on track to finish near the upper end of the 175 to 200 new opening range.

Lastly, let's turn to foreign currency translation, which positively impacted third quarter results by $0.08. At current exchange rates, we expect full year EPS to benefit by about $0.20, which implies a minimal fourth quarter EPS benefit. But as I always say, this is directional guidance only, given the volatility we are experiencing.

Our third quarter and nine-month results are a testament to the strength of the Plan to Win and its effectiveness in a persistently challenging and volatile macroeconomic environment. Our business model is resilient. The alignment within our system is strong, and we are seizing opportunities now to secure an even brighter future for McDonald's. I remain confident that we will continue to drive value for our shareholders over the long term.

Thank you. Now I'll turn it over to Kathy to begin our Q&A.

Question-and-Answer Session

Kathy Martin

[Operator Instructions] So our first question is from Jeff Omohundro from Wells Fargo.

Jeffrey F. Omohundro - Wells Fargo Securities, LLC, Research Division

The Europe performance, Europe sales seem be holding up very well in the face of the economic and political challenges there. I'm wondering if you could give us any color on changes in consumer behavior you might be seeing there? And perhaps, elaborate a bit on the strong performance in September.

James A. Skinner

Jeff, I think first of all, we're very confident in our business model in Europe, and we've continued to perform there. I think, really, August was a bit of an aberration in the overall scheme of things relative to plan days and promotional activities from previous -- from a year ago. And so, we continue to be confident in our initiatives there. And we're not seeing a big impact, really, to our guest counts and the growth in the marketplaces with some of the austerity measures and some of the economic issues that are there, that are impacting certainly discretionary income. And so, it's been actually a good example of how well our business model adapts in these various marketplaces around the world and in different kinds of economic environments we find ourselves in, which is been our history. As you know, it's not the first time we've had to deal with these kinds of things around the world. We've had our presence in Europe for a long time and have gone through various ups and downs in the economies and yet, have been able to deliver steady performance on behalf of brand McDonald's. Because of our business model and the way we're structured, the everyday affordability, as we like to say, our customer's getting pinched everywhere. They shouldn't get that at McDonald's. And even these austerity measures and the lifestyles in Europe, although they can be more harsh in some environments than others, I think the standard of living and the discretionary income has to be impacted very, very severely for us to start to feel that impact at the McDonald's front counter and drive-thru.

Kathy Martin

Next is David Palmer from UBS.

David Palmer - UBS Investment Bank, Research Division

You've been ramping up pricing through the years slowly, and I can understand why you have feel like you have more pricing power than the 2.5% given that 6%-type pricing that's going on at home at home food lately. But my question is on Europe. It feels like you've been fairly stingy on pricing there too away from the VAT, only 2% outside of the hyperinflationary Russia. And given that VATs may not soak up as much of your pricing power in 2012, I would wonder why you wouldn't feel like you can't maintain some sort of moderate pricing next year. What is giving you the conclusion or the feeling that maybe you don't have as much room there, if I'm getting that vibe correct?

James A. Skinner

I think, David, first of all, you're very familiar with our discipline around pricing. And we take it at a point in time in terms of the impact of the marketplace, food away at home, food at home, and as you know, we try to balance that across the indexing. And of course, the economic environment. But mostly, we measure this by the cost environment and this food away from home. And it doesn't mean, based on everything we've said, that we won't look at pricing for next year. We probably will. We look at it on a regular basis but can't really predict when we would take a price increase, because it all matters -- it matters in terms of what we're seeing in the indexing at that point time. I don't know that we've said we don't feel like we have the elasticity there. I just think we're just very, very cautious in the face of the economic environment we find ourselves in over there. And we're going to be very prudent about the way we go about pricing. As you said though, we did take the 2.5% right off the top in the U.K. when they had that VAT change. And I think the important thing is that it hasn't had any impact really on our guest counts and traffic in the restaurants.

Kathy Martin

Next is Michael Kelter of Goldman Sachs.

Michael Kelter - Goldman Sachs Group Inc., Research Division

[Audio Gap] Europe, I mean, what's going on over there? What about the emerging markets? It seems like, as I understand it, GDP is starting to roll over a bit. And in China, more severely at least at this point in Brazil, few other places. Are you seeing any impact your stores?

Peter J. Bensen

Michael, really, I would say no, we haven't. China for the quarter delivered another strong comp. It was 11.3% for the quarter on top of a double-digit comp last year in the third quarter with double-digit guest count growth in both periods. So China continues to perform strongly for us. The other emerging markets within APMEA, so the South Korea, the Taiwans, the Philippines, the Hong Kong, et cetera. All of those helped contribute toward the performance in the quarter and are seeing good sales and traffic growth. We've always talked about the importance of value in that particular region of the world, especially. And it continues to be important. But our formula over there is working well, and we're continuing to see not only good sales and traffic, but the profitability.

Kathy Martin

Next is Keith Siegner from Credit Suisse.

Keith Siegner - Crédit Suisse AG, Research Division

[Audio Gap] in China a little bit, continued very strong results there. And with the commodity outlook, at least at the last update was impressively below the trends in both the commodity markets and what we're seeing from basically almost everyone else in that market. I'm just wondering, is the current -- what is the current commodity outlook for China for this year? And to achieve such a dramatically low inflation relative to others, was this effective contracting? Was there something else? I only ask because if 2011 was a result of really wise contracting, could 2012 turn out to be a much more inflationary a year there? And then, how do you think about pricing in China as a result?

James A. Skinner

Well, Keith, I'll start. And then, I'll let Pete talk to you about the details in terms of what he thinks, say up [ph] what's commodity cost there for the future. But our supply chain, connected with our treasury and our suppliers, do a magnificent job relative to mitigating the impact on overall basis regarding these commodity costs around the world. And sometimes, I don't think they get enough credit for this because we take it very seriously and the process works very well for us. And it's not the case for everybody. They don't simply have that sort of structure or capability. And so, I think that's the reason why you've seen the results you've seen in kind in that regard. Relative to the future, I'll let Pete talk to you a little bit about what we're looking at.

Peter J. Bensen

Yes, and Keith, I know we had an investor meeting over there where we gave some commodity information. That isn't something that we're going to typically update every quarter. But I will tell you that it's based on the things Jim mentioned, and as we have a preliminary look at next year, we don't see any dramatic spike from that. So I don't see us having to do anything dramatically different on the pricing side as a result of commodities. As you know, there's continual pressure on labor over there. And while we continue to keep our rates ahead of the minimums, there's always going to be some constant labor pressure as well. But as we sit today, we don't see anything dramatically different about next year compared to this year that's going to cause any different pricing perspective.

Kathy Martin

Next is Nicole Miller Regan from Piper Jaffray.

Nicole Miller Regan - Piper Jaffray Companies, Research Division

If we can turn back to the U.S. and like everyone else, have a question on pricing. I've heard through the third quarter earnings season so far, some companies reference barbell strategy, and I know you use a tiered approach. Could you talk about the importance of the tiered approach? And then as specific as you can, where do you have the flexibility and what categories or types of items can you tell us where you sort of feel like you could take the price?

James A. Skinner

Well, Nicole, I think -- I couldn't tell you specifically about each one of those categories, to be honest with you. But I leave that up to the U.S. team to figure that out. But the tiered pricing process has given us the opportunity to be able to have value across the menus. So if you look at Dollar Menu, then the tiered pricing and the middle, and some of those great value offerings that we have in the menu, snack wraps, et cetera. And then on the premium end with the premium sandwiches, premium salads, and that sort of thing, we weigh all of that when we take a look at the menu mix relative to pricing and value for our consumer, and then make a decision around that. And I couldn't tell you exactly where the elasticity is. If I could, you'd probably think I'm spending my time in the wrong place. But the U.S. team has every geography is very, very good at this. And it's all based on market consumer data that we use in the pricing mix, as Pete mentioned, food away from home, food at home. And it gets broken down across the menu based on what we know about our product mix in the U.S. and elasticity there.

Kathy Martin

Next up is Greg Badishkanian from Citigroup.

Gregory R. Badishkanian - Citigroup Inc, Research Division

And just as a follow-up on the U.S. pricing, I mean, are you looking more at kind of what your competitors as well as other channels are doing in terms of pricing? Are you looking at your own transactions? And talk about sensitivities, I guess ask with your customers so just kind of looking at that economic sensitivity. What's pretty much the biggest driver, what will determine...

James A. Skinner

I think certainly the biggest drivers is certainly our consumer, and their feelings about our pricing and everyday affordability on the menu. Yes, we take a look at what competitors are doing, but not because we will necessarily make a decision based on that, but we take all things into consideration as we look across the marketplace. But mostly, it's about this index of food at home and food away from home, and we're very judicious about our price increases because maintaining everyday affordability, particularly in the environment that we're in today, is paramount. And we have a pricing model that we use very, very effectively. And yet, it takes intuition and a gut feeling about when to pull the trigger on these kinds of things. And we take all of those factors into consideration because our pricing model and around our commodity cost and our supply chain. And our ability to sort of manage the impact of those costs at the restaurant level is very important to us. And not every other organization that takes prices or moves their pricing up and down has that strength or capability. And so, although we look at what others do and pay attention to that, really, it's an inside game here at McDonald's relative to pricing based on what our consumers are expecting from us.

Operator

Next is Joe Buckley, Bank of America Merrill Lynch.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Can you talk about the modest step-up in expansion plans to 2011? And this reflects maybe a little bit more aggressive posture, those expansion going forward into 2012 and beyond?

James A. Skinner

Yes, Joe. This is Jim. When you look at our numbers around return on incremental invested capital, which as you know, has been one of our hurdle rates since our revitalization plan in all '03, has shown us that we -- because the results have been so great, the goal was high teens, and we've been in the 25th to 40th percentile, depending on what segment of the business you're looking at. And much of that, combined with the average unit volumes of these new restaurants are coming on at, and our development tools that we have been able to use around the world to determine where best to grow and have all come together and sort of given us permission to grow more restaurants around the world. And that's the simple reason. But we spend a very great amount of time around here and due diligence and not just throwing numbers out because we've had good results and say, "Well, we'll just up it." We take a real hard look at the metrics around new store openings and demand that our geographies pay attention to that and continue to deliver on things that are important as we grow the business. But that's really the reason as we -- we've had good results, and the ROI I see has demonstrated that those new restaurants have come online at a very productive and profitable way, and therefore, more opportunity.

Kathy Martin

Next question is from Jason West from Deutsche Bank.

Jason West - Deutsche Bank AG, Research Division

Just had a question on the restaurant-level margins, and I recognize most of the profits are coming from the franchise side. But just touching on the restaurant margins, looking at the items away from food, it would seem you guys would've may be seemed a little bit more leverage on those items this year given the strong comps and just didn't know if there's anything there that's a little bit out of the ordinary or a little more inflationary than you expected. And so, there's an opportunity on some of these items next year to improve the restaurant margins if you have another tough year on inflation.

Peter J. Bensen

Jason, I would say there's nothing in there that was significantly different or is a particular outlier. It just so happens that almost every category of those cost is going in the wrong direction. So utility's up a little bit. Depreciation, up a little bit. That, in part, due to our reimaging efforts. Labor is up. The average wage is up in the U.S. and generally around the world. So there's no one particular item or no particular item is driving a significant piece of it. But just a general inflation across all of the line items is really what's underneath that. And since we look to next year, I don't know that there's going to be anything dramatic on those line items either.

James A. Skinner

It's also important to note that we're right around all-time highs in the margins on the company side. And this all gets back to pricing and top line and how much of that you can mitigate, and certainly, don't know if wanted to do that to the expense of the customers. So we take all that into consideration, but you have to continue to look at the fact that, that number is at a pretty high level relative to the overall history of margins in the company.

Kathy Martin

Next question is Matt DiFrisco from Lazard Capital Markets.

Matthew J. DiFrisco - Lazard Capital Markets LLC, Research Division

Two questions, I guess. You mentioned China and some of the margins there being impact a little bit by the new store development. I wondered, can you describe what we should see over the next couple of years, looking at sort of 50% of your store base is under 3 years old? When does it flip where the new, younger stores are actually starting to ramp up and what does that look like as it progresses in the margins? And then also on Europe, the remodels. I was wondering if you could tell us what we should suspect or what we should expect in what you're seeing as far as same-store sales trends off of those stores have been now remodeled maybe 2 or 3 years ago?

James A. Skinner

Matt, Jim Skinner. I'll start off with China, and I'll let Pete talk about Europe and add his two cents in on China. First of all, the way we've developed in China in the major cities, where we're mainly focused, is through new developments, if you will. So the Chinese are very disciplined around developing new retail outlets and a whole combination of things. They do these like cities, if you will. And so, we go into those because we know we need to be there, but in fact, we go in there early as compared to the overall developments. So you're going to see a benefit, I think, in year 2 or 3 on some of those new stores, which should start to have an impact on that overall margin relative to the new store growth. And it's the best way for us to develop the market because we need to be in those environments. But it takes a little time for them to come on, as the other population retail engagement in those properties begin to come online in a meaningful way.

Peter J. Bensen

And Matt, that isn't dramatically different from what we see in other countries. It maybe 10 basis points higher in China because of some of the specifics Jim mentioned. But generally, they start out a little bit lower, and then by the third year, they've pretty much caught up to the market average. So if you think about what we're doing in China from a development standpoint, we opened 166 last year. We're going to open close to 200 or 200 this year. That kind of incremental ramp up in new stores is really what's kind of causing that impact as we continue to increase the number of openings every year, while slightly have more impact. But it's definitely, at the same time, you've got more stores that are maturing to help offset that. So again, it's not dramatic, but it is something we keep an eye on but is performing consistent with how other markets performed during their kind of their development ramp-up phase. And in terms of the reimaging across Europe, similar to the U.S., those first year comps are up 6% to 7% ahead of the marketplace. And if you've seen the results in Europe over the last couple of years, sales continue to grow in that regard. So we're comfortable that we're still seeing sales increases above the market in those restaurants. And yet, there's more than that just that sales increase that drives improvement in the customer's attitude about McDonald's and the surroundings they're in, their perception of the cleanliness of the restaurant, the quality of service and the food. So it helps build that customer loyalty and drive more repeat business. So it's performing the way we had hoped and expected it to.

Kathy Martin

Next question is from Andy Barish from Jefferies.

Andrew M. Barish - Jefferies & Company, Inc., Research Division

Yes, a quick look out to 2012, and I'm sure we'll get a little bit more detail on this at the Analyst Day next month. But as you look at the U.S. business promotionally, product wise, is there new elements in the marketing strategy for next year? Would you characterize the year next year as more of kind of a line extension and re-hit some of the more recent things?

Peter J. Bensen

Yes. Andy, I think it's probably closer to the latter. I think if you look at the success we've had in 2011 -- so here we are 9 months in, we had some pretty significant weather the first couple of months, and yet, we're still at a 4% comp nine months in. Really, we're at a combination of line extensions and what we call these premium food events, which is a limited time offering. So from the introduction of oatmeal to the barbecue bacon, fourth flavor on the Angus to the Asian salad, which was on for a limited time and a couple of new beverages, et cetera, I think as we review the 2012 calendar for the U.S., it feels like a similar year to 2011.

Kathy Martin

Next question is Mitch Speiser, Buckingham Research.

Mitchell J. Speiser - Buckingham Research Group, Inc.

And as we think about 2012, and Pete, I think you mentioned food costs about in line with 2011. If we look at the third quarter, I think, we all probably think that comps were better than expected, if and margins were worse than expected, when we think about 2012 given the cost that was the same, should we think about continued store-level margin pressure as we try to build out our models?

Peter J. Bensen

Well, Mitch, if you look at the third quarter, specifically in the U.S., costs were up 8%, which was the highest for the year so far. They were up 6% in the second quarter and about 1% in the first. So it's by far was the worst quarter. Europe was up about 5% for the quarter, which was kind of similar to the second quarter for them. But the one thing you have to consider is, certainly, in the U.S., when we flip the calendar to January of 2011, we had 0 pricing increases rolling over from the previous year. Whereas, when we flip the calendar to 2012, those first 2 months will have the benefit of the previous 12 months of price increases that we've taken in the U.S. So that's certainly a factor and something we consider as we think about price increases, frankly, the rest of this year. And I think something similar in Europe, why we don't have the a preliminary estimate nailed down quite yet in Europe with the volatility and some of the currency markets over there and the commodities, they're going to have a year probably that's similar or maybe a little bit better than the U.S. from a cost side. But we'll have an opportunity to refine that and maybe share it at the analyst meeting. But it's going to continue to be, as we look at what is going on in the marketplace, is the consumer in a place that we're comfortable, we can continue to add price increases or continue to monitor the impact on them. If you look, as Jim made some comments about Europe, with everything going on there daily around the sovereign debt crisis and what's going on, especially in the 2 big markets we do business in that are, the ones that are supposed to bail out the continent, hearing that all the time in the press does play on the consumer psyche. So we'll continue to be mindful of that, and we'll do what's going to be best for the long-term business from a price side and managed the input [ph] cost as best as we can.

Kathy Martin

Next question is from Jeff Bernstein from Barclays.

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Just 2 follow-ups. First, on the food cost side of things. May it seems like with 1 quarter to go, you raised both the U.S. and European basket at 50 basis points, which would seem to imply like the fourth quarter is probably riding a couple of hundred basis points above a plan and a quarter ago. Just trying to understand more conceptually how something like that has happened throughout the year in terms of what's locked, what's kind of still exposed, it sounds like it's beef that's the primary driver, but was wondering if you could look at potentially what's contracted, whether we should assume that kind of continued pressure. I don't think you said that you finalize the European basket yet, but just trying to understand kind of how it's contracted out, how it can continues to rise. And then the follow-up question was just on foreign exchange. I think you gave good color on the fourth quarter as the impact, and I don't want to be too specific for next year. But if rates remain where they were right now, kind of what would be the impact, the early read on 2012 FX?

Peter J. Bensen

All right, Jeff. The one issue with the commodities is, we only give you guidance updates once a quarter. And so, you can't necessarily assume that all of the increase in our guidance is going to be felt in the fourth quarter, because we actually started experiencing that in August and September. And so, while we knew the third quarter was going to be probably the highest cost-increase quarter of the year, heading into that quarter, and that's what we had messaged in July. It actually, primarily, because of the beef costs, which as you know, historically, is our least protected and hedged item. That drove the increases. So you're not seeing a 200 basis point deviation from our expectations in the fourth quarter on cost increases. It's actually much closer than that. And we're not going to get into item by item, how much of this is protected. But we've consistently said that beef is the wildcard for us in terms of it has the least amount of locked-in pricing. And so, while we didn't see the traditional falloff in prices after the summer of grilling season that we've historically seen, and that falloff frankly was built into our last forecast. But it's manageable for us. And the good news is, in the fourth quarter in the U.S., those cost increases are going to be well below what they were in the second and third quarters. So that's good. And probably at the analyst meeting is when we'll start to give a first look at currency. To be honest with you, I haven't even formulated a view on that yet.

Kathy Martin

Next question is from John Ivankoe from JPMorgan.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

A question I think related just on the products overall in the U.S. for 2012. I mean, certainly, the new point-of-sale system does allow increased speed and accuracy, so we want to get a sense of how that might influence product development, what you offer to the customers and whether 2012 or beyond. And secondly, given the fact that in sort of your competition is you kind of backed-off focus, I mean, perhaps by necessity on their value menus and what your thought is of promotion of your Dollar Menu in 2012, I mean, might it be less than what it's been in previous years based on less from the competition?

James A. Skinner

Well, I don't -- John, this is Jim. I don't know for sure exactly how much emphasis we want to put on Dollar Menu for next year, except to say Dollar Menu is here to stay. We have supported our franchisees for the Dollar Menu going into 2012. The system for alignment around everyday affordability is extraordinarily strong. And it's going to continue to be important, and we will continue to communicate that to our consumers. And so, I don't see a lot of change there. Relative to overall menu development and new product news, the U.S. is going to probably continue to talk about breakfast. They'll talk about big sandwiches and other mid-tier. The problem we have with a company like McDonald's is that the expectation around communication around all those of things is expected by our consumers. And of providing them that choice on the menu has to continue to get better, not get stale or go soft. And so, I expect that we will continue to communicate strongly around all of those day parts and all of those menu platforms.

Peter J. Bensen

And John, as you pointed out, the new register system is certainly one of the tools that will help facilitate that. Our old register system couldn't have handled in any reasonable way the additional choice and variety that Jim is mentioning. And it helps facilitate the introduction more easily as some of these what we call premium food events or rotating events that items will come on the menu for 6, 8, 12 weeks and then go away, we couldn't have done that as easily or efficiently with our old register system. So it is definitely a key piece of our menu strategy.

Pete, just a question on overall franchise profitability. I was wondering if you had any insight on how franchisees have been able to manage through the current environment in terms of their own cash flow profitability and whether they're seeing some of the similar pressures you're seeing on the restaurant cash flow margin line? And if so, has that made them any less enthusiastic about investing in initiatives like reimaging or any of the product initiatives you have coming?

James A. Skinner

Yes, David, this is Jim. Although, I think you asked Pete the question, I was just with franchisees last week and the week before that here in the United States. And of course, we pay very close attention to franchisee cash flow and profitability going all the way back to Ray Kroc, who said, "First, the franchisees make money, and then everything else follows." And we've not changed our philosophy around that in 55 years. And so, the headline is, that it continues to be very, very good. It is off slightly this year, but it's off a record high last year. And the franchisees I think are very, very pleased, particularly, when you look at the alignment of the organization around our initiatives, which we collaborate on very closely. First of all, we don't make decisions here at the center and then bark our orders to our franchisees. They're part of the process in the Plan to Win. And to profitability, regarding those initiatives, it's always a factor as we move forward with the progress and the sustainable growth of the organization, which revolves around the cash flow for the franchisees. It's a very good place right now and continues to be in a good place. And much of this because of the system support for the franchisee profitability, as we talked earlier about supply chain and locking and food costs that are going to be appropriate for them to be able to maintain some level of cash flow that's important to them. In spite of the fact that we have these enormous commodity-cross increases that we've operated with, we work together. We do a very good job on this, and I think you would find that they're very happy and supportive of the initiatives and because we decide together.

I just wanted to kind of wrap back to the U.S comp broadly and say, "I think it's been so impressive in terms of how much you've outpaced the market and certainly the macro indicators." So you've talked a little bit about initiatives. Can you kind of bucket where -- are you spending more on advertising in total? Is it just that your competitors are spending less? Is it are you doing better? Are your comps better in breakfast, for example, or snacking, where you tend to be more dominant? Just trying to understand, in the absence of a major product launch, how it is that your comp trend has been so sustainable for so long?

James A. Skinner

Sure, this is Jim. First of all, on the communication in the share voice, on advertising with our consumers. It's remained as a percentage of historical expense, about the same and about the same nationally, except to say that we will continue to maintain those levels during the recession and the downturn. And so, our shared voice continues to be very, very strong, and we've always had the attitude of McDonald's that we need to be communicating at the same or greater levels during difficult times as compared to healthier times. And so, that's continued to grow and be very, very effective for us. But that's been the case really forever around here. Relative to the day part growth, we've had day part growth really across the board. And I talked in my comments this morning about the growth around the breakfast and some of the items, the Egg McMuffin and the value items and the nutritional items, oatmeal and the rest. And so -- and we're very balanced in our communication with our consumers around these things without -- because we don't have the luxury of pushing one side of the business versus another side of the business, because we've got such high hurdles to really get over regarding the overall experience throughout the entire business day. And so we're very pleased with the results. But I think you would see a very sort of deliberate, focus around all of day parts and communication and continuing to maintain our share of voice, which by the way is very supported nationally by our franchisees and they're somewhere in the 1% to 2% range and overall store contribution, with local contribution is somewhere in the 3% to 6% range. And it's sort of been that way for the last few years.

Kathy Martin

Next question is from Brian Bittner, Oppenheimer.

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

When you look at the stores that you'll be remodeling across the globe over the next few years, what percentage, if you can quantify, are more than just an interior-exterior phase? With what percentage of these really of the opportunity to meaningfully increase the throughput and efficiency of the store kind of outside of just implementing new POS systems?

Peter J. Bensen

Brian, I don't have the specific reimage plan by country in front of me over the next couple of years. But I will tell you that a majority of them have an opportunity to undergo a major improvement. What we see in the U.S., and this probably should make sense, but when we're able to, because we have enough real estate, add a side-by-side drive-thru, at the same time, we're doing the full interior and exterior reimage, we're seeing the greatest sales increase. And anything we can do to increase that capacity is going to just kind of exponentially improve the sales that you get from just doing the reimaging interior and exterior. But we look at that, and as Jim mentioned in his remarks, if we don't have the real estate to do the side by side, then we go down and say, "All right, well then, let's use a handheld order taker to try to get those multiple order points in the drive-thru to increase our capacity." And I think today, we have almost 1,000 of those handhelds in the U.S. and increasing those numbers. So there is plenty of opportunity to continue these improved results that we're seeing today.

Kathy Martin

Next question is from RJ Hottovy from MorningStar.

Ronald J. Hottovy - Morningstar Inc., Research Division

Just a quick question about the international McCafé rollout especially I see you moved past hot beverages. Just wondering if you had any expectations in terms of incremental sales per location? In the past, you talked adding about $125,000 per location in the U.S., and I believe that's the whole beverage platform, but just any kind of expectations with the international McCafé rollout?

James A. Skinner

RJ, this is Jim. On the McCafé, we've served beverages around the world differently forever, really. So if you like, you can take McCafés. McCafés really started in Australia. McCafés have expanded in Europe. Europe really had what they would call their McCafé program before the United States. And so, the United States version, of course, in line with the front counter, so we can facilitate drive-thru. These are all really different concepts. And yet, with the expansion of the blended iced drinks and the smoothies and the other kinds of things into the markets around the world, I would say that, okay, as we review our plans coming up in the next month or so for 2012 from the area of the worlds, I would doubt whether they really have that quantified to the extent where I would be able to tell you what expectation is on a store-by-store basis. The reason why we quantified it the way we did for United States is because you asked us to, one. And two, because at a wholesale basis, we were rolling out something that was going to impact nearly 14,000 stores. And so, we were capable of doing it that way because it was a unified program that was consistent throughout every store. We don't have that same experience in every store other than the fact that if you're selling fruit smoothies, that might be consistent. But the footprint platform and the ability for us to be able to expand McCafé is somewhat different in every market.

Kathy Martin

Okay, and this will be our last question, as we're running out of time. It is from Jon Tower from Morgan Stanley.

Jon Tower - Morgan Stanley, Research Division

Given what's going on in the European macro environment, just curious to know if you're beginning to see any lower labor turnover at the store level and/or any lower cost advertise in that market?

James A. Skinner

I wouldn't say, Jon, that we've seen anything significant there. We've had very good results over the past number of years because of our people migration plans and understanding the relationship as you modernize the experience in the restaurant. It has to be modernized for the customer or for the employees as well. And we do a lot of things there to retain our people in the organization. And yet, I wouldn't say that because of austerity or the unemployment numbers or any of these other issues that we're facing, all of our people around the world that, that yet has changed significantly.

Kathy Martin

Okay, with that, I'll turn it back to Jim with -- he has a few closing comments.

James A. Skinner

Yes. I just like to say thanks for joining us this morning. In closing, I want to reemphasize the ongoing strength of our global business and our confidence in the continued success of our brand. I think we've demonstrated our fundamentals, and Plan to Win strategy is strong and I'm optimistic that we will continue to drive results in the future. Thanks, and have a great day.

Operator

Thank you. And this does conclude today's conference. We thank you for your participation. At this time, you may disconnect your line.

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